The S&P 500 has risen for the past eight consecutive weeks. One begs to ask, who is actually long this market? Certainly, institutions and retail investors are not long and enjoying these gains, as can be seen by the consistent weekly ETF outflows -- despite the S&P 500 surging back to November highs close to 2800.
To put it in perspective, the S&P 500 was threatening to break 2350 at the end of December, so we have had a whopping 19% rally from the lows. That is a year's worth of performance in one month -- allowing a trader to take the entire year off, if they called it right. Other than momentum (CTA) funds, no one is really long here, as the market has climbed a wall of worry silently.
On some days, the market has seen sudden bursts of panic buying, like the one witnessed on Friday, as the U.S. and China decided to hold further trade talks this week -- and after China reported its gargantuan liquidity injection for January. Beijing injected more credit in January than the GDP of Saudi Arabia! One should never underestimate the power of central bank liquidity as it injects capital into the system, which helps boost asset prices -- including equities, commodities, etc. -- and squeezes out shorts.
One of the limiting factors for the market last year had been the Fed's rising interest rate and balance sheet normalization policy. After Powell caved in at the start of the year, this hurdle had been removed from the market. President Trump is very happy to have the "Fed on board," as it seems he finally got what he was targeting last year all along; a looser and more accommodative monetary policy. One begs to ask the question of whether this so-called Trade War was just a smoke screen to coerce the Fed by scaring them -- giving them enough ammunition to hold off on quantitative tightening.
Since Trump benchmarks the success of his presidential campaign by the level of the S&P 500, this paves the way to agree on any deal that will cause the market to rally and be enough to claim a victory and possibly seal the deal for the second term. Call me cynical, but there is more drama here than the hottest show on Netflix (NFLX) . Will China concede to U.S. dictating their domestic policy agenda, or just smooth-talk them by agreeing to import more and balance the deficit a bit. Will the average Joe really know what is in the deal, other than it just being a deal?
The Fed is in a bit of a pickle. They got spooked by markets collapsing in December and then backed off. However, if one looks only at the data, now with the S&P 500 only 3.5% away from all-time highs, one wonders when they will or should start raising interest rates again. The 300,000 payrolls number print for January and higher labour costs certainly imply higher interest rates going forward.
Employment remains strong. Inflationary pressures, as seen by the PPI, CPI, and Core PCE, all show a rising trend -- one that denotes rising interest rates not a pause in the cycle. Unless the Fed knows something we don't, I doubt it, as they are always backward looking. The irony of the matter is that if there were to be a recession, the Fed is starting with a balance sheet closer to $4 trillion with interest rates at 2.2% vs. the last time around, with the balance sheet at less than a billion dollars and rates of 4.2%. Very little room to manoeuvre this time.
It is astonishing how just a few one-liners from U.S. and Chinese officials saying "talks are going well" have helped the markets grind higher in last few weeks. They have met several times with no actual progress announced, just a new venue and more talks to be held. Chinese Vice Premier Liu He will now visit Washington on February 21-22 to meet with U.S. Trade Representative Lighthizer and Treasury Secretary Steve Mnuchin. The market will likely grind higher into this event. If we keep getting these positive teasers until then, investors who are out of this market could be forced to go back in, allowing the S&P 500 to touch 2900.
For now, the momentum is positive. Let's see what comes out of the talks this week. For now, enjoy the ride, but do not get emotionally attached to your positions.